European Union: Restrictions On Subcontracting In European Government Contracts

A ruling from Europe's highest court has confirmed that public entities across the EU cannot impose volume limits on subcontracting by requiring a government contractor to perform a specified percentage of the works itself under a public contract.

Over the years, issues of subcontracting have generated a steady flow of cases before the European Court of Justice ("CJEU"). How should government contractors implement subcontracts and flow-down the terms of their prime contracts? What role does evaluation of subcontractors play in overall bid evaluation? What is the effect of a change in a key subcontractor?

Partly as a result of the uncertainty in this area, the most recent iteration of the EU procurement directives (Directive 2014/24/EU on public procurement (the "2014 Directive")) provides greater guidance to public bodies about their scope for monitoring and controlling the use of subcontractors. Underlying the enhanced powers in the 2014 Directive, however, are the principles from this most recent case, which effectively prohibit a contracting authority from restricting a contractor's ability to subcontract, save in certain circumstances.

While this most recent CJEU case (Wroclaw Miasto na prawach powiatu v Minister Infrastruktury i Rozwoju ("Wroclaw")) was decided under a previous EU procurement directive that has since been updated and re-stated, the salient points from this case will continue to apply to the way in which European contracting authorities treat subcontractors.

Key facts

The Roads and Maintenance Board of the City of Wroclaw in Poland (the "Board") concluded a public contract relating to the partial construction of a bypass. The tender specification for the project required bidding contractors to agree to perform at least 25% of the works for tender using their own resources.

At the time, Polish law permitted a contracting authority to specify the share of the contract that could not be subcontracted. This was subsequently amended to clarify that subcontracting was permitted, unless otherwise specified by the contracting authority. A claim for financial correction was brought against the Board (because the bypass project had received EU financial assistance), on the basis of an alleged breach of Directive 2004/18/EC (the "2004 Directive"), the EU procurement law that was in force at the time. For present purposes, the relevant question referred to the CJEU was whether a contracting authority can require a contractor to perform a minimum percentage of the works under a public contract using its own resources.

The CJEU held that the primary position under the EU procurement regime was that there should be no limitation on subcontracting, save in specific circumstances where the restriction can be justified by a legitimate interest in ensuring that the contract is properly executed. But the court set out three conditions that must be met by a contracting authority to enable it to validly restrict the use of subcontractors:

1. The procurement documents must require tenderers to indicate the share of the contract that they may intend to subcontract.
2. The proposed performance by the subcontractor must be of an essential part of the contract.
3. The relevant subcontractor's capacities cannot be verified.

In Wroclaw, the 25% requirement did not meet these three conditions. Rather, it was a fixed, arbitrary limitation that did not apply to particular "essential" parts of the contract, and was not related to the subcontractor's capacities.

Outcome: What does this mean for contracting authorities?

The outcome of the Wroclaw case was that the infringement of EU law was held to constitute an "irregularity" (meaning, a provision of EU law with the effect of prejudicing the general budget of the EU) based on the possibility that, in the absence of the 25% restriction, tenderers would have been able to subcontract more than 75% of the works, resulting in potentially more economically efficient tender offers. A financial correction (in the amount of 5% of the eligible costs borne by public funds) was therefore applied.

While EU contracting authorities may prefer to simplify their supply chains by using contractors with in-house capabilities, they must take care not to fall afoul of their obligations under EU procurement laws.

Essentially, Wroclaw boils down to these key takeaways:

• The use of subcontractors in EU public contracts can only be restricted where the capacities of those subcontractors cannot be verified for the performance of essential parts of the contract.
• A contracting authority must be trying to protect a legitimate interest in restricting a contractor's ability to delegate its obligations to subcontractors.

After the legislative changes, is the case still relevant?

Will the case still be relevant after changes are made to EU laws? In short, yes. As has already been mentioned, the Wroclaw case was decided under the 2004 Directive. Since then, greater clarity was brought to the EU procurement regime by the 2014 Directive. Some countries, such as the UK, have even further clarified the interpretation of the subcontracting rules under EU procurement law. In the UK, this has been done via the Public Contracts Regulations 2015 (the "PCRs"), which implement the 2014 Directive into national law, and were supplemented by additional government guidance on the new subcontracting provisions. This guidance summarized the subcontracting provisions as imposing one additional obligation, and providing two additional powers for contracting authorities, as set out below:

However, while the UK regulations appear to grant contracting authorities greater powers of scrutiny over subcontractors, the overriding principles of the Wroclaw case remain valid in relation to tender specifications and the way in which subcontractors are treated by contracting authorities in European procurements.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved